Compounding Interest And The Importance Of Starting Early

It’s no secret that financially independent people who retire early start saving early. The early years of saving make one of the biggest impacts you have on your financial lifespan. So why is it then that so many people make the mistake of not saving?

The best way I can illustrate this concept is to introduce you to two friends – Brody and Murphy.

Brody just celebrated his 21st birthday. He recently graduated from college and got his first “big boy” job. Brody has always been pretty cautious with his money and has made the commitment to save $1,000 per year in his retirement account right out of the gate.

Murphy also just celebrated his birthday, but has a few more years under his belt at the age of 31. Murphy has been working for several years but didn’t take advantage of his company’s retirement benefits. After talking with Brody about his new job, Murphy decides that he wants to also make the commitment of saving $1,000 per year.

Ten years pass and Brody has a new baby girl. As a result, he can no longer put $1,000 per year in his retirement savings. Murphy continues to put $1,000 per year, every year, until he eventually retires at the age of 66 years old.

Now the question: Who has more money saved in their retirement accounts if both Brody and Murphy had their investments allocated exactly the same?

Brody’s contribution to his retirement was $10,000 (Age 21-31). Murphy on the other hand, contributed $35,000 (Age 31-66).

Initially, you might think that Murphy would have a lot more money in his retirement account. However, because of the concept of compounding interest – Brody would actually have a higher balance in his account. Compounding interest, simply put, is the interest on your interest plus your principal, or your face amount of your investment.

Let’s break this down. Assume both Brody and Murphy averaged 8% return every year that they were invested. Brody’s first $1,000 is going to earn him $80.00 in interest to make his retirement account balance be $1,080. His second $1,000 is going to add to that making $2,080. That $2,080 is going to earn $166.40 in interest. Let’s take a deeper look at Brody’s results.

Brody

Age

Contribution

Interest Earned

Retirement Balance

21

$1,000.00

$80.00

$1,080.00

22

$1,000.00

$166.40

$2,246.40

23

$1,000.00

$259.71

$3,506.11

24

$1,000.00

$360.49

$4,866.60

25

$1,000.00

$469.33

$6,335.93

26

$1,000.00

$586.87

$7,922.80

27

$1,000.00

$713.82

$9,636.62

28

$1,000.00

$850.93

$11,487.55

29

$1,000.00

$999.00

$13,486.55

30

$1,000.00

$1,158.92

$15,645.47

31

$0.00

$1,251.64

$16,897.11

32

$0.00

$1,351.77

$18,248.88

33

$0.00

$1,459.91

$19,708.79

34

$0.00

$1,576.70

$21,285.49

35

$0.00

$1,702.84

$22,988.33

36

$0.00

$1,839.07

$24,827.40

37

$0.00

$1,986.19

$26,813.59

38

$0.00

$2,145.09

$28,958.68

39

$0.00

$2,316.69

$31,275.37

40

$0.00

$2,502.03

$33,777.40

41

$0.00

$2,702.19

$36,479.59

42

$0.00

$2,918.37

$39,397.96

43

$0.00

$3,151.84

$42,549.80

44

$0.00

$3,403.98

$45,953.78

45

$0.00

$3,676.30

$49,630.08

46

$0.00

$3,970.41

$53,600.49

47

$0.00

$4,288.04

$57,888.53

48

$0.00

$4,631.08

$62,519.61

49

$0.00

$5,001.57

$67,521.18

50

$0.00

$5,401.69

$72,922.88

51

$0.00

$5,833.83

$78,756.71

52

$0.00

$6,300.54

$85,057.24

53

$0.00

$6,804.58

$91,861.82

54

$0.00

$7,348.95

$99,210.77

55

$0.00

$7,936.86

$107,147.63

56

$0.00

$8,571.81

$115,719.44

57

$0.00

$9,257.56

$124,976.99

58

$0.00

$9,998.16

$134,975.15

59

$0.00

$10,798.01

$145,773.17

60

$0.00

$11,661.85

$157,435.02

61

$0.00

$12,594.80

$170,029.82

62

$0.00

$13,602.39

$183,632.21

63

$0.00

$14,690.58

$198,322.78

64

$0.00

$15,865.82

$214,188.61

65

$0.00

$17,135.09

$231,323.69

66

$0.00

$18,505.90

$249,829.59

Not bad at all! Brody’s $10,000 investment came to be nearly a quarter of a million dollars when he was retired.

Now let’s see how Murphy did. Remember, Murphy didn’t start until he was 31.

Murphy

Age

Contribution

Interest Earned

Retirement Balance

21

$0.00

$0.00

$0.00

22

$0.00

$0.00

$0.00

23

$0.00

$0.00

$0.00

24

$0.00

$0.00

$0.00

25

$0.00

$0.00

$0.00

26

$0.00

$0.00

$0.00

27

$0.00

$0.00

$0.00

28

$0.00

$0.00

$0.00

29

$0.00

$0.00

$0.00

30

$0.00

$0.00

$0.00

31

$1,000.00

$80.00

$1,080.00

32

$1,000.00

$166.40

$2,246.40

33

$1,000.00

$259.71

$3,506.11

34

$1,000.00

$360.49

$4,866.60

35

$1,000.00

$469.33

$6,335.93

36

$1,000.00

$586.87

$7,922.80

37

$1,000.00

$713.82

$9,636.62

38

$1,000.00

$850.93

$11,487.55

39

$1,000.00

$999.00

$13,486.55

40

$1,000.00

$1,158.92

$15,645.47

41

$1,000.00

$1,251.64

$16,897.11

42

$1,000.00

$1,431.77

$18,328.88

43

$1,000.00

$1,546.31

$20,875.19

44

$1,000.00

$1,750.02

$23,625.21

45

$1,000.00

$1,970.02

$26,595.23

46

$1,000.00

$2,207.62

$29,802.85

47

$1,000.00

$2,464.23

$33,267.08

48

$1,000.00

$2,741.37

$37,008.45

49

$1,000.00

$3,040.68

$41,049.12

50

$1,000.00

$3,363.93

$45,413.05

51

$1,000.00

$3,713.04

$50,126.10

52

$1,000.00

$4,090.09

$55,216.18

53

$1,000.00

$4,497.29

$60,713.48

54

$1,000.00

$4,937.08

$66,650.56

55

$1,000.00

$5,412.04

$73,062.60

56

$1,000.00

$5,925.01

$79,987.61

57

$1,000.00

$6,479.01

$87,466.62

58

$1,000.00

$7,077.33

$95,543.95

59

$1,000.00

$7,723.52

$104,267.46

60

$1,000.00

$8,421.40

$113,688.86

61

$1,000.00

$9,175.11

$123,863.97

62

$1,000.00

$9,989.12

$134,853.09

63

$1,000.00

$10,868.25

$146,721.33

64

$1,000.00

$11,817.71

$159,539.04

65

$1,000.00

$12,843.12

$173,382.16

66

$1,000.00

$13,950.57

$188,332.74

As you can see, Murphy continued investing $1,000 every year. The difference in the two is that Brody had more time for his money to work for him. Murphy didn’t start saving until he was 31.

So what’s the $61,496.85 lesson here? Time. Time is hands down the most valuable asset a young investor has. This is why it is so incredibly important to get started thinking about retirement early. It doesn’t even have to be $1,000 as you start working, so long as you start with something. Make room in your budget to pay yourself first so that your money can start working for you right away. One tool Victoria and I do to track our expenses and find ways to put more into our retirement is by using Personal Capital. It’s a free resource to see all of your accounts in one handy location. We’ll have a post in the near future on becoming a power user of it, but it’s so easy to use that we want to share it with you now.

I hope these numbers weren’t too intimidating and encourage you to think about your retirement. One of the goals Victoria and I had with The Millenniaires was to make financial education approachable and relatable. If you need help coming up with a plan, reach out to us and let us help you. We want to see a new generation of wealth!

Don’t forget to find us on Twitter and let us know over on our Facebook page how you’re saving for retirement!

-Archie

3 Comments

An absolutely great example of the value of compounding over time!!! Very proud to see something took! Keep up the good advise….very proud to see this great word getting out. Save everything you can and live within your means… not within anyone else’s expectation and you will enjoy a long retirement!!!